Chapter 4 — What Is an SEP?

A Simplified Employee Pension (SEP) is a traditional IRA that may receive employer contributions at a much higher level than is permitted under regular IRA rules. To operate properly, each eligible employee must have an IRA to accept the employer’s contributions. Any employer — whether a corporation, partnership, or a one-person sole proprietorship with no other employees — may establish a SEP.

SEPs are particularly useful for persons who are regularly employed by a company but also “moonlight” for themselves as independent contractors. Because these individuals can establish a SEP for their self-employment income in addition to any workplace plan they participate in as an employee, SEPs are sometimes referred to as a “moonlighter’s retirement plan.”

While originally designed for small business employers, there is no limit on the size of employer that may establish a SEP. Large corporations may also use them, though the administrative simplicity of a SEP is most advantageous for small and mid-size businesses.

An employer who establishes a SEP must generally cover each and every employee who has:

• reached age 21,
• worked for the employer during the year in which the contribution is made,
• worked for the employer for at least 3 of the previous 5 years, and
• received at least $750 in compensation (2026, inflation-adjusted from the original $300/$450 figures) for the year in which the contribution is made.

These are the maximum eligibility conditions an employer may impose. An employer may use more liberal eligibility rules (for example, covering employees immediately) but may not be more restrictive than the four criteria above.

A SEP plan must be established in writing and must include:

• a formula for the allocation of contributions among eligible employees,
• provisions governing participation,
• vesting (all SEP contributions are immediately 100% vested), and
• nondiscrimination — contributions must be a uniform percentage of compensation for all eligible employees.

A SEP is the only type of employer-sponsored retirement plan that can be established after the tax year has ended. The plan must be established no later than the employer’s income tax filing deadline for the year in which contributions are being made — including extensions. This makes SEPs extremely attractive for businesses that don’t know their financial results until tax time.

An employer is not required to contribute to a SEP every year. The decision to contribute — and how much — is left entirely to the employer. In effect, a SEP operates like a profit-sharing plan: contributions are discretionary, may vary from year to year, and may even be zero in a given year.

When contributions are made, they must follow a written allocation formula that is uniform across all eligible employees — typically a fixed percentage of each employee’s compensation. Contributions are limited to the lesser of 25% of each employee’s compensation or $72,000 (2026), with compensation capped at $360,000.

For tax and legal purposes, a SEP is officially adopted when:

• IRAs have been established for all eligible employees,
• the agreement form has been completed without modification (for a Model SEP), and
• employees have received disclosure statements informing them of the existence of the plan, that IRAs involve investment risk, and that the plan administrator will notify them of any contributions made into their accounts no later than January 31 of the following year.

The final two steps are typically accomplished by signing and distributing IRS Form 5305-SEP to all eligible employees.

The IRS has developed a one-page standardized plan document — Form 5305-SEP — that meets all legal requirements for a Simplified Employee Pension and requires no special document preparation. This pre-approved model is the simplest, most efficient, and least expensive way for a small business to establish a retirement plan.

An employer may use the Model SEP (Form 5305-SEP) only if:

• the employer does not currently maintain any other retirement plan and has not maintained a defined benefit plan at any time in the past,
• an IRA has been established for each eligible employee,
• the employer does not use the services of leased employees, and
• all eligible employees of all members of an affiliated service group, controlled group of corporations, or trade or business under common control participate in the SEP.

Because Form 5305-SEP is a pre-approved IRS model, no favorable ruling from the IRS is required and the form is not filed with the IRS. The employer simply retains a signed, dated copy of the completed form in its business records and provides each eligible employee with a copy.

Employers using a Model SEP generally do not file annual reports (Form 5500) with the IRS — unless the employer selects or influences the choice of IRA into which contributions are deposited and those IRAs contain special withdrawal restrictions beyond the standard IRA rules.

Employers using a Model SEP may not integrate SEP contributions with Social Security (permitted disparity). Social Security integration is discussed in the Top Heavy Rules & Integration section. Employers who wish to integrate contributions must use a Non-Model SEP.

The IRS allows employers to create unique (non-model) SEP plans with provisions not available under Form 5305-SEP — such as Social Security integration, different allocation formulas, or other customizations.

Financial institutions — including banks, credit unions, insurance companies, savings and loan associations, mutual fund companies, and professional associations — may request IRS approval for their own prototype SEPs. These institutions find it advantageous to design proprietary prototype plans as a way to offer combined plan documents and investment services to employer clients (“one-stop shopping”).

Unlike Model SEPs, non-model SEPs must be approved by the IRS. A copy of the proposed plan must be filed with the IRS requesting a “favorable ruling,” and any subsequent amendments must also be filed and approved.